Confused by Economic Forecasts? There's a Good Reason
With all the varied estimations of the chances that the U.S. is headed into a new recession, someone must have gotten it right ... right? But whom?
Is it the Federal Reserve Bank of San Francisco, which recently published a research paper estimating that the odds were "greater than 50-50" that the U.S. will experience a recession sometime in 2012? That view was backed up by Pacific Investment Management CEO Mohamed A. El-Erian, who recently told Bloomberg TV that he found the economic conditions in the U.S. "terrifying" and placed the odds of the country entering a new recession as high as 50%.
What about surveys of economists that take a more optimistic view? The National Association for Business Economics recently said that as a group, "the panelists saw a recession as the least likely scenario." How unlikely? A 7.4% probability. That's about two out of 49 economists surveyed.
Then there's a Nov. 4 poll conducted by Reuters that found that Wall Street economists put the odds of a recession next year at 30%, down from 35.5% a month earlier.
Plenty of Opinions, Little Precision
It's no wonder investors are having a difficult time digesting the divergent views of experts that have appeared in the media lately.
"Nobody has a good track record in predicting recessions," says Patrick Newport, an economist at IHS Global Insight, in an interview. "Anybody who says they know what's going to happen doesn't know what they are talking about."
Part of the problem is that we live in confusing times. Part is that nuanced economic analysis doesn't often produce the sensational headlines the media craves. Plus, economic forecasting is as much an art as it is a science.
Take the Federal Reserve paper. Authors Travis J. Berge, Oscar Jorda and Early Elias argue that the U.S. would be dragged into a recession in the event of a European sovereign debt default. But what are the odds of that, and what would be the precise impact here? Answer cloudy, ask again later. "Because the international odds of recession are more imprecisely estimated, one must be careful with a strict interpretation of this result," they write in the report. "However, if we navigate the storm through the second half of 2012, it appears that danger will recede rapidly in 2013." The authors were not available for comment.
There are economists who share the paper's pessimistic tone. Newport, whose views are part of the NABE survey, places the odds of the U.S. entering a recession in 2012 at 40%, up from an earlier forecast of 25%. The reason for his heightened worries, not surprisingly, is the ever-changing situation in Europe.
"We see no reason to lower our view" of a recession's probability, Newport said.
Is There Wisdom in Crowds?
Parthenon Group deputy chief economist Richard DeKaser, who is part of the NABE committee that administers the survey, says that investors should pay closer attention to the consensus of experts rather than the views of a particular individual.
"History has shown that the most realistic predictors [of future economic activity] are consensus-based surveys," he said.
Nonetheless, it's the job of economists such as Newport and DeKaser to make their best educated guess about the future of the economy, because policy needs to be proactive rather than reactive. Not providing a forecast is not an option because that sends the message that things are not changing, which in all likelihood isn't true.
Investors who are confused shouldn't feel bad: The economic situation we're in is so unprecedented that experts aren't sure what may happen next either. So take all the predictions with a grain of salt, and wait like everyone else to see what the future holds.
Motley Fool contributor Jonathan Berr urges readers not to be led astray by sensational headlines.